Can you trust the interest rate forecast, especially on medium-term personal loans (24 to 72 month installments)? Yes, but with caution. See here how and why.
Every time we search for the best personal loan, we have to look at at least two things. You’d think first is how good is the offer compared with all other offers? No, this is second. First should be to see how that loan will become in time. And this is all about interest rate forecast. You look also for two things: would you afford the loan until the last installment, and what should you choose, fixed interest rate or variable interest rate?
So back to the big question: an you trust an interest rate forecast? Yes and no. Yes, on short and medium term, if nothing special is happening in the world, the evolution can be predicted. No, on longer term all forecasts become uncertain, and that “if nothing happens” changes for sure.
How can we do a proper interest rate forecast?
Well, we can’t. We will never have access to information, data and tools as the banks have. We’re no university. We’re not even experts in trends and forecasts. But there are things we can do, and do them well. Let’s take a look on what banks are doing when dealing with long term loans: they prefer variable (adjustable, floating) interest rate, calculated as “reference rate + bank margin”. The reference rate is the variable part, while the bank margin is fixed, and by contract cannot be changed without both parties consent.
So, what’s the reference rate? Depending on the type of credit, it can be the Prime rate, MTA or Libor. The Prime rate is used especially on short term loans, such us credit cards. MTA and Libor are widely used for long term loans, such us mortgages, but also for medium term personal loans. Since this is our topic, we’ll base our analysis on MTA and Libor. First we have to understand them, then see their evolution. Only after that, we will try to see how the personal rate interest forecast can be tight to either one of them (or both).
Time-frame, data and forecast methodology
Economy evolution is quite volatile and difficult to predict. While the main cycles remains the same, two things changed: everything is a lot faster than before, and everything is global. It almost doesn’t matter how well an economy is doing, when another on is falling, all is falling. The life-span of an economic cycle is a lot shorter from crisis to crisis, and many times the cycles are overlapping.
So, how can we choose the time-frame for our analysis? 10 years is too much, 1 year is too little. We chosen two years: one Obama year and one Trump year. Yes, is arbitrary, but there is something named “educated guess”. And we have to keep in mind: we try to do an interest rate forecast on 24 to 72 months personal loans. So the data we used is starting in February 2017 and is ending in January 2019 (most recent available data).
12-MTA is 12 month average of the monthly average yields of U.S. Treasury securities adjusted to a constant maturity of one year. This index is commonly used are reference rate – as a component of the interest rate formation. Even though you will not see it when you take a fixed interest rate loan, is very possible the bank is using it to calculate the offers.
As you can see, 12-MTA is having a very clear increasing evolution, going from 0.376% to 2.397% in only 2 years (more than 6 times higher).
12 month US Dollar LIBOR interest rate evolution
The 12 month US Dollar (USD) LIBOR interest rate is the average interest rate at which a selection of banks are lending to one another in American dollars with a maturity of 12 months. Compared to 12-MTA, is a more international index.
The same as 12-MTA, LIBOR USD 12m evolution trend is up, but with a more “real-life” variations. Libor USD 12m now is almost 6.5 times higher that 2 years ago.
Libor USD 12m vs. 12-MTA
Here is an overlapping analysis of the two indexes:
So the Libor US Dollar 12 month interest rate is growing higher and faster than 12-MTA. Is this important to our analysis? How is this helping us to get the best interest rate forecast on personal loans? For the time being, no help, but we will see soon the relevance – because it is relevant.
Interest Rate evolution on 24 Month Personal Loans at Commercial Banks
What we will show here might look weird, after the two graphs we’ve seen already. While banks are paying a lot more interest rates on the loans they’re taking from other banks, the interest rates they are offering on personal loans hasn’t raised 6-7 times over. Take a look:
The 2-year trend in commercial banks interest rates on personal loans is also a growing one, but not at all as exponential as the two banking indexes presented above.
Interest rate correlation with reference indexes
You’ll see here two graphs in one: Interest rate average evolution against 12-MTA and Libor USD 12m – top graph, and the same bellow, but with one “trick”. Read the explanation after the image.
Graphic correlation between 12-MTA, Libor USD 12m and TERMCBPER24NS
Since the absolute values of the three interest rates are quite apart, is difficult to see which of the two reference ones is the closest in evolution to the average interest rate on personal loans. What we have done: we modified the interest rate on personal loans column, starting it from zero. We have deducted the exact number from each row (month), and this way we have obtained the raw evolution.
Which reference interest rate is closest in evolution to personal loans one?
Take a new look at the graph, you will see it, clear as crystal: interest rate on personal loans evolution is extremely close to Libor USD 12m one.
Finally, we’ve got something we can use. How we can use this information? All we have to do is to use a serious prediction on Libor USD 12m evolution, and we will be able to forecast quite seriously the evolution of the interest rate on personal loans. Right? Right, is simple science, a science named usually “econometry”.
Interest rate forecast – the results
Again, our base, as we prove it, is the correlation between interest rate evolution against Libor USD 12m. The similar evolution trend is obvious, isn’t it?
And here, based on the international authority Global-rates.com prediction on Libor, our own interest rate forecast over the next 6 months.
Although the 6 months forecasting might seem very few, for 24 month data series is more than enough.
These results shows what many financial and banking analysts are already saying: the interest rates on 2019 will reduce the increase trend.
They will still rise, but on a much slower pace, almost steady.
Great. How is this analysis help you? Your choosing, but here are some questions you might get to ask:
- Question: Is this a good time to choose a variable interest rate loan? Answer: in the loan is not on long-term, and the initial variable interest rate is lower than the fixed one, might be a good idea.
- Question: Is this a good time to get a personal loan, or should I wait? Answer: The interest rate forecast is stable, so choose your timing based on your own need and schedule.
References and data sources
- 12 Month Treasury Average – go to moneycafe.com
- 12 month US Dollar LIBOR interest rate – go to global-rates.com
- Finance Rate on Personal Loans at Commercial Banks, 24 Month Loan (TERMCBPER24NS) – go to stlouisfed.org